I’ve tried to avoid commenting on Trump’s Fed bashing, as I don’t wish to insult my reader’s intelligence. But the media reports that Trump is now bashing the Fed on an almost daily basis, in order to have a fall guy in case the economy turns south. So I suppose I must say something:

1. In the real world, presidents don’t get to excuse policy failures by pointing to the mistakes of government officials thattheythemselves appointed. But of course we no longer live in the real world; we live in TrumpWorld, where it is rhetoric, not reality, that matters. (If you want a good laugh, read a serious media report (say the NYT) where they go out and interview Trump voters who explain why they are thrilled with Trump’s performance. Great accomplishments like the peace deal with North Korea.)

2. OK, enough Trump bashing. What about the substance of his complaint? Here I’d say he’s very likely wrong, but not obviously crazy. The indicators I look at (NGDP, inflation, unemployment, etc.) do not indicate that money is too tight, but there’s at least a small possibility that we still don’t have a credible 2% PCE inflation rate going forward. It’s at least debatable.

3. If you talk to the average economist, point #2 is what they’d complain about. Most economists don’t see money as being too tight. But the real problem is elsewhere; Trump assumes that interest rates represent the stance of monetary policy. Even worse, he thinks that low rates mean easy money. Other economists are less likely to ridicule Trump for this error, as many economists are similarly confused.

The Fed influences the economy in many ways. One method is by adjusting the policy interest rate (fed funds or IOR). A far more important way is by affecting the natural rate of interest. Thus the Fed sharply reduced the natural rate in 2008, while only gradually reducing the policy rate. To the average economist (and to Trump) the Fed was “easing” monetary policy. In fact, because the natural rate was falling even faster than the policy rate, they were tightening policy.

How does the Fed affect the natural rate of interest? By shifting the expected NGDP growth rate (and also the level of NGDP relative to trend.) A tight money policy (such as late 2007 through 2008) will reduce NGDP growth expectations, and this reduces the natural rate of interest. That’s what Trump doesn’t understand, but it’s also what lots of economists don’t understand. Even the smarter economists, the one’s that understand it’s the gap between the policy rate and the natural rate that matters, often think that the natural rate is falling due to external “shocks”, not bad Fed policy.

So by all means ridicule Trump for the insanity of excusing potential policy failures by pointing to the mistakes of his own appointees, but don’t bash him for making the same mistake that many economists make. Instead, it’s the economists that deserve ridicule.

By the way, this is the clearest, easiest description of your position I’ve yet seen.

Since inflation is caused by the gap between the policy rate (as set by the fed today) and the natural rate ( as determined by expectations of the Fred’s future behavior), is it fair to say that inflation is the difference between current fed policy and expected future policy?

Another way of looking at it is that, when the expected rate of money supply growth falls short of the previous expected growth rate, demand for money increases proportionally, at the expense of demand for output. This is because the expected rate of return on money increases versus output. Wages adjust much more slowly, and perhaps never completely, hence an increase in unemployment.

‘Trump assumes that interest rates represent the stance of monetary policy. Even worse, he thinks that low rates mean easy money. Other economists are less likely to ridicule Trump for this error, as many economists are similarly confused.’

I agree completely. Trump’s error is the result of the majority of the economics profession’s error. Why is it so hard to understand that interest rates are NOT the price[s] of money?

Agreed. Curiously, Obama was even more clueless regarding monetary policy, which was too tight during the majority if not the entirety of his administration. But Obama did have the character to not assail his own appointees.

In terms of policy, I must confess I agree with Trump. There is plenty of slack in the labor market (official unemployment measures have become misleading) and I think the new standard is that it is better to error on the high side rather than risk chronic slow growth and disinflation, the norms in Europe and Japan.

Also, the optics presently are just terrible to try to clampdown on the economy. We have reached a state where corporate profits are at all-time record highs relatively and absolutely. This is great news.

But the moment we see some real wage growth, the Fed hops to it and says that we must clampdown.

I often say the Fed should shoot for full-tilt boogie boom times in Fat City. We are there in terms of corporate profits. Now that that wages might interrupt a little… Time to tighten up, says the Fed.

I wonder how voters will react to this type of monetary and economic policies.

I’m sure in the past you’ve referred to the stance of monetary policy as being indicated by expected NGDP growth (eg the Bernanke quote). Now you’re saying the Fed affects the natural rate of interest by shifting the expected NGDP growth rate and NGDP growth relative to trend. That seems to be a fuller definition of the same thing as the stance. Is the way in which the Fed affects the natural rate of interest the same thing as the stance of monetary policy? If so, it seems that the policy rate is – at least above the ZLB – the primary tool the Fed uses to effect a certain stance. Again if so, the policy rate should not be considered as a separate way of influencing the economy apart from its role in determining the stance (aka, the natural rate of interest). An implication of this approach is that other things being equal, a given path of the policy rate should map onto a given path of Fed stance. Or am I missing something?

“But of course we no longer live in the real world; we live in TrumpWorld, where it is rhetoric, not reality, that matters. (If you want a good laugh, read a serious media report (say the NYT) where they go out and interview Trump voters who explain why they are thrilled with Trump’s performance.”

BTW, Trump is something of a creampuff in relation to the Fed, compared to some of his predecessors.

The New York Times recently reported regarding LBJ:

“[Fed Chair] Martin flew down to the Johnson Ranch on Monday, Dec. 6, along with Fowler and other advisers. The president met them at an airstrip behind the wheel of his Lincoln convertible. They piled in and he drove them to the house.

There, Johnson got Martin alone and did not mince words. According to different accounts, the 6-foot-4 Johnson pushed the shorter Martin up against a wall.

“You went ahead and did something that you knew I disapproved of, that can affect my entire term here,” Johnson said, as Martin recalled later in an oral history. “You took advantage of me and I’m not going to forget it, because here I am, a sick man. You’ve got me into a position where you can run a rapier into me and you’ve run it.”

“Martin, my boys are dying in Vietnam, and you won’t print the money I need,” he said.

Martin stood his ground. He pointed out that he had given the president fair warning that a raise was coming. More broadly, he insisted that he and the president had different jobs to do, that the Federal Reserve Act gave the Fed responsibility over interest rates.

“I knew you disapproved of it, but I had to call the shot as I saw it,” he said.

The two eventually stepped outside and tried to assure reporters that any differences had been patched up. Their sour expressions, captured in newspapers the next day, suggested otherwise.”

But even LBJ was topped by Ronald Reagan. Reagan decided shoving matches and blow-harding was was Hollywood, not the real stuff. Why not gut the Fed, and make it part of the US Treasury? Get out the long knives…..

Nor was that an odd one-off proposal by a confused Reagan. His Treasury Secretary Donald Regan proposed the institutional realignment of the Fed with executive power on several occasions. They were in earnest.

I happen to think Reagan was right in this case. Macroeconomic policy-making should be transparent and accountable. Far weightier matters are not governed by independent boards, such as going to war (after LBJ and Bush Jr, we might hope so, but the power rests with elected officials.)

But Trump is not alone in his evaluation of the Fed (though he is alone in being the guy who appointed Powell and in his garishness). Paul Krugman, Larry Summers, Adam Ozimek, Tim Duy and David Beckworth have all raised concerns, ranging from slightly future tense to the here-and-now.

“An implication of this approach is that other things being equal, a given path of the policy rate should map onto a given path of Fed stance. Or am I missing something?”

I’m not quite sure what you mean. Is there a relationship between the interest rate and the stance of policy? Yes. Is there a relationship between the price of zinc and the stance of policy? Yes. Is the interest rate a useful way to identify the stance of policy? No.

The Fed influences the economy in many ways. One method is by adjusting the policy interest rate (fed funds or IOR). A far more important way is by affecting the natural rate of interest.

It seems to me that assuming other variables as given, if the way the Fed affects the natural rate is another way of describing the stance of monetary policy, then the policy rate is not independent of the way in which the Fed affects the natural rate. In other words, I am saying it would be more accurate to simply say the Fed influences the economy through its stance and not mention the policy rate other than as one of the tools it uses for effecting its stance.

“To the average economist (and to Trump) the Fed was ‘easing’ monetary policy. In fact, because the natural rate was falling even faster than the policy rate, they were tightening policy.” This is such a simple point that even I can grasp it. So what’s wrong with the average economist (I won’t ask about Trump!)? Examples like this–and there are similar groundless fads in all other areas of intellectual endeavor–have largely undermined my faith in the accepted experts. Unfortunately, the heretics are even more likely to be wrong (with rare exceptions, such as Scott Sumner). Skepticism triumphant!

P.S.: I’d be happy if *you* understood Rorty: then you would stop praising him!

Scott – yes that’s exactly what I meant. And thanks for an even pithier summary

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.